Argentina’s debt bonanza buys time, raises risks

Posted on October 26, 2016

Less than a year ago, Argentina was on the brink of a balance of payments crisis after 12 years of populist rule. But dollars have flooded into the economy since the business-friendly government of Mauricio Macri took over last December, with central bank reserves last week surging above $40bn.

Although the record set by Argentina’s bumper $16.5bn return to the capital markets this year has already been broken by Saudi Arabia, the government is continuing to startle investors with an aggressive debt strategy, in recent weeks issuing $8.5bn of long-term, fixed-rate peso-denominated bonds.

In a remarkable show of confidence in the government’s success in stabilising an economy that it inherited with double-digit inflation and liquid foreign exchange reserves close to zero, most of the demand for the 5, 7 and 10-year peso bonds was from international emerging market local debt funds.

“This shows a strong conviction that the central bank will succeed in bringing down inflation to single digits within just a few years,” says Andrew Cummins, founder of Explorador Capital Management, a US-based hedge fund focused on Latin America.

A combination of what he says are “some of the highest real interest rates in the world” and a “solid sovereign balance sheet” makes the peso bonds an attractive vehicle for the “carry trade”, where investors borrow at low interest rates in one jurisdiction to buy higher-yielding assets elsewhere.

Nevertheless, Walter Stoeppelwerth, head of research at Balanz Capital, a local investment bank, says there is “some concern about when these guys are going to stop issuing debt”. After officials said they would not return to the markets this year, it sends a signal that a fiscal deficit of about 7 per cent is “not really improving”, he argues.

“They’ve been back, and back, and back [to the markets]. They’ve tapped just about every investor class you could possibly think of, placing as much debt as they can — and that’s starting to chafe with some people,” he says, adding that it is still “good news” that the government has now pre-funded its financing needs for the rest of the year.

This year public entities have issued $40bn in debt — three-quarters of it in foreign currency — raising public debt to 50 per cent of gross domestic product, up from 43 per cent last December, according to the Institute of International Finance.

Furthermore, there is mounting speculation that Argentina may be angling for inclusion in JPMorgan’s $809bn GBI-EM benchmark bond index for emerging market local currency bond investors by removing limits on foreign investor purchases of local bonds. That would open a whole universe of investors able to buy Argentine local debt, helping the country to reduce its reliance on foreign debt and so put an end to a long history of debt crises.

“Investors are providing the liquidity the government needs to finance the regime change,” says Martin Castellano, an Argentine economist at the IIF.

Ultimately, the global hunt for high yields is helping Argentina to postpone a painful but unavoidable fiscal adjustment until after next year’s midterm legislative elections, when the government is hoping to strengthen its position in congress to consolidate its reform programme. For now, analysts are optimistic that expected economic growth of about 3-4 per cent next year, after a contraction of up to 2 per cent in 2016, will help the government’s electoral performance.

Even so, despite the government’s impressive progress in solving a barrage of economic problems — including removing strict capital controls and ending a long-running debt dispute that was preventing access to the capital markets — interest rates in Argentina remain higher than other countries in the region. While Argentine sovereign debt yields about 6.5 per cent, Colombia can borrow at closer to 2 per cent.

“Argentina’s financing costs have fallen, but the fiscal deficit is a weakness which limits their ability to finance themselves at lower rates. For interest rates to come down more, the fiscal situation needs to improve,” says Mr Castellano.

Mr Castellano argues that the main risk for Argentina is “complacency”. A decisive fiscal consolidation programme, including a clear multiyear path to cut public utility subsidies, must be put in place after next year’s elections “to dispel the risk of chronic fiscal deficits”. Failure to do so will leave the country vulnerable to shifts in market sentiment, and could derail Mr Macri’s reform programme, he argues.

“They can’t keep borrowing at these levels every year,” says Balanz Capital’s Mr Stoeppelwerth, who agrees that without a solution to the fiscal situation investors could begin to lose confidence. “At some point the well is going to run dry.”

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